BoE finds potential vulnerabilities in financial market plumbing

By David Milliken

LONDON (Reuters) -The Bank of England said on Friday that a stress test of central counterparties (CCPs)- businesses that form a key part of the plumbing of financial markets - did find some vulnerabilities but overall showed resilience.

The stress test focused on the credit resilience of the clearing services provided by ICE Clear Europe, LCH - part of LSEG, and LME Clear, which is owned by Hong Kong Exchanges and Clearing Ltd.

"The stress test results do not suggest that this is a cause for concern, but we continue to monitor CCPs resources through ongoing data collection and supervision," Bank of England Deputy Governor Sarah Breeden said.

LME Clear, the clearing house of the London Metal Exchange, was found to be most vulnerable of the three to the stress test, based on an escalation of geopolitical and trade tensions culminating in an upward shock to commodities markets.

The stress test was not a pass or fail exercise, and did not look at CCPs' liquidity or the wider impact of their failure, which will be assessed separately.

The BoE said the central counterparties, which are involved in the clearing and settlement of financial trades, were tested against a scenario that involved market stress similar to the largest recorded plus the default of two of the biggest CCPs.

Some CCPs were found to be holding fewer financial resources than at the time of a previous stress test in 2022, which took place after a period of market turmoil, the BoE said.

"When we extend the stress test to include the cost of liquidating highly concentrated positions and more conservative assumptions, we identify some potential areas of vulnerability, which we will explore with CCPs as part of our ongoing supervision," Breeden said.

LME Base - part of LME Clear which focuses on base metal trading - was vulnerable to a default by two members with large concentrated positions and would need to draw on additional resources in this scenario, the BoE said.

The central bank said this conclusion was sensitive to the exact assumptions about liquidation costs, and it would follow this up with LME, which had increased pre-funded resources since the test date.

"We ... are pleased that LME Clear performed robustly despite the stress test scenarios not being tailored to metals market dynamics," the LME said.

"Over the last 18 months we have implemented measures to further bolster the resilience of our clearing house and are currently consulting on further enhancements."

LME's base metals clearing was identified as vulnerable in 2022's stress test, after it had to suspend nickel trading earlier that year.

In July, the BoE launched a consultation for new post-Brexit rules for central counterparties and other similar businesses.

(Reporting by David Milliken; additional reporting by Eric Onstad; Editing by Kate Holton, Andy Bruce and David Evans)